HELOCs Just Got a Lot More Interesting

By Jonathan Washburn, The Solido Group · NMLS #1645952

@thedeanofmortgages

Our HELOCs have always been fast. Now the rates are finally catching up. 👀 If you’re sitting on a 3–4% mortgage and need to access your equity, replacing that entire mortgage might make absolutely no sense. There may be a much better way. #HELOC #HomeEquity #MortgageTips #MortgageBroker #SolidoGroup

♬ nhạc nền – Plennus – Plennus

For years, when someone asked me about a Home Equity Line of Credit, I found myself offering them a rather unsatisfying choice.

Would you like it quickly, or would you like it cheaply?

In the mortgage broker world, we have always been able to deliver the first option.

In the right circumstances, I can potentially get someone approved for a HELOC and give them access to their money within just a few business days. This is no small advantage when the money is actually needed.

But conveniences, as we all eventually discover, have a habit of sending us a bill.

The Old Tradeoff With Broker HELOCs

The HELOCs available to us were fast, simple, and useful, but not always the cheapest in town. We might have been offering a rate that was a full point or two higher than a big bank or local credit union.

And so I told people exactly that.

If time mattered most, come to me. If time didn’t matter and the lowest possible rate did, compare my offer with your bank.

It was not a particularly exciting sales pitch, but I have always thought that telling someone the truth is preferable to giving them a better sales pitch.

Lately, however, something has changed.

What If HELOCs Didn’t Force You to Choose?

One of our wholesale lending partners (shoutout Averra!) recently introduced a HELOC option that has made this old tradeoff considerably less obvious.

We still have the speed.

But now, the pricing has become much more competitive.

As I write this, I am working on a fixed-rate HELOC for a well-qualified client that, incredibly, has a LOWER interest rate than regular cash-out refinances!

A HELOC.

I confess that when I first saw the pricing, I checked it twice.

And this comes at a particularly interesting moment, because mortgage rates today are back above 7%.

Which brings us to something I think many homeowners do not fully appreciate.

Your 3% Mortgage Is an Asset

Suppose you owe $300,000 on your house at 3.25%.

You have made your payments. Your house has increased in value. You have accumulated a considerable amount of equity.

And now you need $50,000.

Perhaps you are renovating the house. Maybe there is some large expense. Or perhaps you have substantially more expensive debt elsewhere that you would like to eliminate.

There are several ways to get the money.

The Hidden Cost of a Cash-Out Refinance

One would be a cash-out refinance.

You could replace your existing $300,000 mortgage with a new $350,000 mortgage and receive the additional $50,000. This sounds perfectly sensible until we notice what we have actually done. We needed to borrow $50,000, so we refinanced $350,000.

More importantly, we took $300,000 that had been happily sitting at 3.25% and moved it into a world where mortgage rates are now around 7%.

It is rather like owning a perfectly good car outright, needing new tires, and deciding that the obvious solution is to trade in the entire automobile.

You have solved the tire problem.

But did that cost make sense?

Your 3.25% mortgage is valuable.

It may not feel valuable because you see it every month. Familiarity has a peculiar way of making valuable things seem ordinary.

But if someone offered you the ability today to borrow $300,000 at 3.25% for the remainder of your mortgage term, you would immediately recognize what an extraordinary financial asset that is.

And yet, some homeowners voluntarily surrender exactly that asset when they refinance simply because they need access to a relatively small portion of their equity.

A HELOC allows us to ask a different question:

What if we simply left the good mortgage alone?

Keep the $300,000 at 3.25%.

Then borrow the additional $50,000 separately.

A Little Arithmetic Helps

There is a useful concept here called a blended interest rate.

Suppose you owe:

$300,000 at 3.25% on your existing mortgage

and

$50,000 at 6.99% on a new HELOC.

Altogether, you now owe $350,000.

But you are not paying 6.99% on $350,000.

You are paying it only on $50,000.

The other $300,000 remains safely tucked away at 3.25%.

When we weight those two rates according to the amount borrowed, the blended rate across the $350,000 is lower than 4%.

Now we must be careful here, because arithmetic can tell the truth and still tempt us to draw the wrong conclusion from it.

This does not mean that you possess a single $350,000 fixed-rate mortgage at 3.78%.

You don’t.

The two loans have different terms and potentially different repayment structures. HELOCs commonly have variable interest rates, which means the HELOC rate and payment can change over time.

But the calculation reveals something important.

The important question is not merely:

“What rate am I paying on the new money?”

It is also:

“What am I doing to the old money?”

And that second question is very easily forgotten.

Sometimes the Best Thing You Can Do to a Mortgage Is Nothing

We have a natural tendency to think that when we need money from our house, we must “do something” with our mortgage.

But sometimes the wisest thing you can do with your existing mortgage is absolutely nothing.

Leave it alone.

If you were fortunate enough to borrow a large sum of money at 3%, 3.5% or 4%, there ought to be a very good reason before you voluntarily surrender that rate.

This is one of the reasons HELOCs can be so useful in the current market.

They allow us to separate two questions that are often unnecessarily combined:

What should I do with the money I’ve already borrowed?

And:

How should I borrow the new money I need today?

The answer to the first question may be:

Nothing at all.

HELOCs Also Give You Flexibility

There is another advantage.

A HELOC is a line of credit, not simply a pile of money deposited into your bank account on the first day.

Suppose you are planning a $75,000 renovation.

You may not need $75,000 today.

Perhaps the contractor needs $20,000 now, another $15,000 several months from now, and the remainder as the project progresses.

With a HELOC, you can generally draw from your available credit during the draw period as you need it.

And as you repay what you have borrowed, that available credit can generally replenish during the draw period. Further, you will ONLY pay interest on the amount that you have actually borrowed, just like a credit card.

This makes a HELOC particularly useful when you know you may need money but do not know precisely how much you will need or precisely when you will need it.

There is something pleasantly sensible about borrowing money only when you actually need to borrow it.

Now for the Slightly Awkward Part

There is something else about HELOCs that people in the mortgage industry do not always spend much time discussing.

Loan officers are generally compensated based on the amount of money that you are borrowing. This means the loan officer will almost always make less on a $50,000 HELOC than on a potential $350,000 cash-out refinance. (Loan Officer compensation rules make sense when you really think about them. A Loan Officer should not charge a higher percentage on certain loan amounts than he does on other loan amounts — this could very easily lead to discriminatory lending practices.)

How Incentives Can Push Bigger Loans Over HELOCs

Suppose again that you owe $300,000 and need $50,000.

There are two possible conversations a loan officer might have with you.

In the first, we refinance your entire mortgage and originate a new $350,000 loan.

In the second, I tell you to leave your $300,000 mortgage exactly where it is and help you obtain a $50,000 HELOC.

You will notice that one of these loans is seven times larger than the other.

And it would be naïve to imagine that financial incentives never influence financial advice.

This does not mean that a loan officer recommending a cash-out refinance is behaving dishonestly. There are plenty of circumstances in which a cash-out refinance is precisely the right thing to do.

But incentives matter.

We ought to acknowledge them.

At the Solido Group, we believe that our job is not to discover the largest loan we can persuade someone to take.

Our job is to help borrowers discover which loan actually makes the most sense.

Those are not always the same thing.

Of Course, Equity Is Not Free Money

Having said all of this, we must avoid making the opposite mistake.

Home equity is not a bank account.

If your house has appreciated by $200,000, you have not discovered $200,000 of free money hiding behind the drywall.

To access that equity, you must borrow against it.

And borrowed money must eventually be repaid.

A HELOC is debt secured by your home. Most HELOCs have variable interest rates, which means the rate and payment can increase. Eventually the draw period ends and the loan enters its repayment period.

So the existence of equity is not, by itself, a reason to borrow against it.

The question should never be:

“How much money can I get out of my house?”

The better question is:

“What am I trying to accomplish, and what is the least foolish way to accomplish it?”

Sometimes the answer is a cash-out refinance.

Other times it is a fixed second mortgage.

Or it might be a HELOC.

And sometimes—and this is an answer lenders admittedly have less incentive to advertise—the best loan is no loan at all.

Why I’m Excited About HELOCs Right Now

For years, my HELOC conversation was simple:

I can probably do this much faster than your bank, but your bank may beat my rate.

It was an honest tradeoff.

Today, that tradeoff is becoming much less pronounced.

If we can combine the speed and simplicity that made broker HELOCs attractive in the first place with genuinely competitive rates, then the product becomes much more interesting.

Especially now.

HELOCs Keep the Cheap Debt Cheap

There are millions of homeowners sitting on mortgages in the 3s and 4s while current mortgage rates are above 7%.

Those old mortgages are worth protecting.

If you need $50,000, it does not necessarily follow that you should disturb the other $300,000.

Keep the cheap debt cheap.

Borrow only what you actually need.

And before you refinance hundreds of thousands of dollars at today’s rates, ask whether there is a way to accomplish the same objective without sacrificing one of the best financial assets you already possess.

For a lot of homeowners right now, the answer may be a HELOC.

And for the first time in a while, you may not have to choose between getting one quickly and getting one at a competitive rate.

The rates and scenarios discussed in this article are examples for educational purposes and are not a commitment to lend or a guarantee of available pricing. Interest rates, terms and eligibility vary based on borrower qualifications, property characteristics, loan amount, combined loan-to-value and other underwriting requirements. HELOCs commonly have variable interest rates, and rates and payments may change over time. Consult with a qualified mortgage professional to compare the costs and terms of available financing options.

This article is for general educational purposes only. It is not an offer or solicitation, a commitment to lend, a rate quote, or financial, legal, or tax advice. Loan program guidelines, rates, and requirements change and vary by borrower, lender, and state; confirm current details with a licensed loan officer. All loans are subject to credit approval. The Solido Group is a branch of Barrett Financial Group, L.L.C., NMLS #181106. Not all products are available in all states; see our licensing page. Equal Housing Opportunity.